For Investors, Japan Picture Still Clouded

U.S. investors hoping that Japan’s election surprise on Sunday would be a watershed for Asia’s battered financial markets came away disappointed on Monday.

While stocks rallied 1.7% in Tokyo, they fell in most other Asian markets. But the yen didn’t collapse, as some experts predicted. And on Wall Street, stocks closed mixed in mostly dull trading--suggesting confusion rather than worry or relief.

In trading early today, most Asian markets rose modestly, while the yen was stable at about 141.50 to the dollar.

Voters clearly expressed their ire with Japan’s economic torpor when they dealt the ruling Liberal Democratic Party a humbling defeat Sunday. And the vote may one day prove to have been the impetus forcing the government into decisive action.

But until then, many analysts say Japan’s investment climate remains little changed--and perhaps even a bit more uncertain. And that may continue to weigh on beleaguered markets across Asia, where investors have been counting on a recovery in Japan to lift the region out of deep recession.

Far from guaranteeing progress, Ryutaro Hashimoto’s resignation as prime minister raises a host of new questions: Will a reformer succeed him? Can that person forge consensus within the fractured LDP, not to mention newly invigorated opposition parties? And--most important--would any consensus call for sufficiently aggressive economic action?

It will be some time before investors--both those who already have money in the region as well as others trying to jump in at what they hope is the bottom--get answers to those questions.

And investors must grapple with something else. Even if political leaders adopt a reformist stance, Japan’s economy is likely to get worse before it gets better, experts say. That’s because reform measures would inevitably boost unemployment and perhaps deepen the economic slowdown as banks unwind their labyrinth of bad loans.

“We’ve gone back a few steps where we’ve got to figure out who’s doing what before we get to the ‘solution,’ which itself has a huge social cost attached to it,” said Miren Etcheverry, manager of the John Hancock Global stock fund. “Japan is going to be a difficult market over the next year or so.”

Not surprisingly, managers of many international mutual funds have steered clear of Japanese stocks in recent years. Managers of Japan-specific funds, who do not have the luxury of avoiding the country, have clung to blue-chip exporters such as Sony and Honda.

Some fund managers are cautiously optimistic that the election will force Japan to enact credible economic reforms--such as permanent income tax cuts to spur consumer spending.

“It’s possibly a watershed event--and I stress possibly--because of the fact that maybe the average Japanese has been shaken out of complacency and indifference to vote to ‘throw the rascals out,’ ” said Nick Bratt, director of the global equity group at Scudder Kemper Investments Inc.

In its funds investing throughout Asia, Bratt’s firm has only about 15% of its assets in Japan. About a quarter of the money is in Hong Kong and a fifth in Taiwan.

Mark Headley, co-manager of the Matthews Pacific Tiger Fund, which invests in Asian nations other than Japan, has recently put money into depressed Thailand and South Korea because he feels they’re the furthest along in enacting their own economic reforms.

David Warren, co-manager of the T. Rowe Price Japan fund, has invested heavily in exporters. He also has lately put money into domestic stocks such as home builders and retailers. Those stocks have been hit hard but should gain as the economy recovers, he said.

That points up the challenge for investors: Markets are anticipatory and tend to rally well before good news about an economy becomes apparent. That means Tokyo stocks are almost certain to rally in advance of a broadly acknowledged pickup in the economy.

The risk still is in jumping in too early. As Warren points out, several false starts in Japan’s market since 1990 occurred when investors expected an election to bring true reform. For example, enthusiasm greeted reform-minded Prime Minister Morihiro Hosokawa’s victory in 1993, but scandal forced him from office within eight months.

“We’ve been there and done that and gotten nowhere in the past,” Warren said. “The danger is that this is another one of those occasions.”

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* LEADERLESS JAPANESE FRET

Japan fears political gridlock as it seeks a new premier. A1

* RULING PARTY CANDIDATES

The front-runners to take the helm in Tokyo are insiders. A6

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Asia’s Mixed Response

Japanese stocks rallied Monday after the ruling party’s stunning defeat in parliamentary elections, but most other Asian markets fell, deepening their year-to-date declines. Key markets’ performance Monday and year-to-date:

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Pct. Year-to-date Market/index Mon. close chng. pct. change Japan/Nikkei-225 16,360.39 +1.7% +7.2% Indonesia/composite 459.67 -0.8 +14.4 Taiwan/composite 7,815.53 -0.9 -4.5 S. Korea/composite 301.37 -1.2 -19.7 Hong Kong/Hang Seng 8,099.20 -1.3 -24.5 China/Shenzen B 77.68 -1.4 -21.5 Philippines/composite 1,775.85 -1.5 -5.0 Malaysia/composite 421.31 -1.7 -29.2 Thailand/SET 266.75 -2.7 -28.4 Singapore/Straits Times 1,053.19 -3.4 -31.2

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Note: Performance measured in native currencies.

Source: Bloomberg News